The income statement takes only the difference between the opening allowance and the new closing allowance. If the new balance is bigger, the difference is an expense. If it is smaller, the difference is a gain.
This lesson belongs to year-end adjustments that students confuse. The full bad-debt sequence is in handling bad debts and allowances.
What does the ledger account look like?
Draw the allowance account before calculating. The opening balance sits on the credit side, the closing balance is carried down, and the gap is the adjustment.
The account always balances, so the missing figure is the income statement entry.
Worked example 1: the allowance falls
Receivables are RM60 000 before year-end. A bad debt of RM2 000 is written off. The allowance is 3% of remaining receivables. The opening allowance balance is RM2 000.
- Remaining receivables = 60 000 − 2 000 = RM58 000.
- Closing allowance = 3% × 58 000 = RM1 740.
- The account opens at RM2 000 and needs only RM1 740, so the decrease is 2 000 − 1 740 = RM260.
- Debit Allowance for doubtful debts RM260, credit Allowance adjustment (income statement) RM260.
Profit rises by RM260 from the allowance. Bad debts of RM2 000 remain an expense, so the net expense is 2 000 − 260 = RM1 740.
Worked example 2: the allowance rises
Receivables are RM40 000. A bad debt of RM1 000 is written off. The allowance is 10% of remaining receivables. The opening allowance balance is RM3 000.
- Remaining receivables = 40 000 − 1 000 = RM39 000.
- Closing allowance = 10% × 39 000 = RM3 900.
- Increase = 3 900 − 3 000 = RM900, an expense.
- Total expense for the year = 1 000 + 900 = RM1 900.
The mistake that costs marks
The mistake is to charge the closing allowance in full. In the first example that would put RM1 740 as an expense, when the business actually released RM260.
| Step | Wrong | Right |
|---|---|---|
| Result in example 1 | Expense RM1 740 | Gain RM260 |
| Result in example 2 | Expense RM3 900 | Expense RM900 |
| Statement of financial position | Receivables only | Receivables less closing allowance |
The fix is to always compare two balances: opening and closing. Put both balances on the same ledger account before you decide.
Check yourself
Receivables are RM80 000. RM4 000 is written off as a bad debt. The allowance is 5% of remaining receivables, and the opening allowance is RM3 500. State the allowance adjustment, the total expense and the net receivables.
Answer
Remaining receivables = 80 000 − 4 000 = RM76 000.
Closing allowance = 5% × 76 000 = RM3 800.
Adjustment = 3 800 − 3 500 = RM300 increase, an expense.
Total expense = 4 000 + 300 = RM4 300.
Net receivables = 76 000 − 3 800 = RM72 200.
What to study next
Continue with showing how one adjustment affects both financial statements. For guided help with ledger accounts, see online one-to-one Accounting tuition.